Bank of England governor Mark Carney delivers strongest hint yet that interest rates could rise before the end of the year

Mark Carney last night issued a sobering reminder of the ‘rapid and treacherous waters’ that could throw the UK recovery off course.

In his first annual Mansion House speech, the Bank of England governor gave the strongest indication yet that interest rates could rise before the end of the year and described the perils ahead for the economy.

He said he would look to his ‘trusty canoe’ to ‘navigate the most rapid and treacherous waters’.

Test: Chancellor of the Exchequer George Osborne, right, is followed by Mark Carney, Governor of the Bank of England at Mansion House

These include a housing market which could ‘overheat’, high levels of household debt and a record current account deficit.

Carney hailed progress made since his predecessor Lord King delivered his final Mansion House speech last year, with the economy now growing at an annualised pace of 4 per cent and employment rising ‘at record pace’.

But he warned the UK economy is ‘currently unbalanced internally and externally’, adding this had to be addressed to turn the recovery into a ‘durable expansion’.

Bank officials and politicians are concerned that the country is too reliant on soaring house prices and domestic consumption fuelled by borrowing.

Meanwhile, ‘external’ imbalances have been driven by flagging exports, as the malaise in the eurozone has stunted demand. The current account deficit – often seen as a sign of a country living beyond its means – has hit £22.4billion.

Carney pointed to ‘old imbalances persisting and new ones emerging.’

He added: ‘The economy is still over-levered. The housing market is showing the potential to overheat. And the current account deficit is now at a record level.’

He warned households around the country that a hike in interest rates could come sooner rather than later. ‘There’s already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced.

‘It could happen sooner than markets currently expect.’

The Bank is assuming that markets expect rates to rise by next spring. But he assured listeners that ‘we expect that eventual increases in Bank Rate will be gradual and limited’, arguing that caution was needed because a ‘highly indebted private sector is particularly sensitive to interest rates’.

The comments represent the Bank’s strongest warning yet that interest rates are set to rise, perhaps before the end of the year. After previous assurances that it is in no rush to increase rates, officials at Threadneedle Street have hardened their stance.

Rate expectations: The chart shows how the money markets see interest rates changing at the time of the May inflation report - expectations are now likely to shift forwards.

Outgoing deputy governor Charlie Bean has already indicated that a rate hike could start before the end of the year, with rates settling at around 3 per cent between 2017 and 2019.

And Ian McCafferty, who sits on the Bank’s Monetary Policy Committee, said this week that the case for raising the base rate from its current record low of 0.5 per cent was becoming more ‘balanced’ as the economy strengthens.

A rapid fall in unemployment and a stronger than expected recovery has prompted a change in thinking at the Bank.

Under Carney’s new policy of ‘forward guidance’ the Bank initially said unemployment falling to 7 per cent would be a trigger for considering an increase in the base rate.

Unemployment now stands at 6.6 per cent, which has prompted markets to assume a rate hike is imminent.

Carney also addressed fears over the housing market. Citing the proportion of new mortgages at high loan to income ratios hitting an all time high, he welcomed measures outlined by the Chancellor to stop the housing market overheating.

These include handing new powers to the Bank to limit the proportion of high loan to income mortgages which each bank can lend.